Yahoo Finance Should You Be Tempted To Buy IMI plc (LON:IMI) Because Of Its PE Ratio?
This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
IMI plc (LON:IMI) is trading with a trailing P/E of 21.1, which is close to the industry average of 21.7. While IMI might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for IMI
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for IMI
Price-Earnings Ratio = Price per share ÷ Earnings per share
IMI Price-Earnings Ratio = £11.31 ÷ £0.537 = 21.1x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to IMI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. IMI plc (LON:IMI) is trading with a trailing P/E of 21.1, which is close to the industry average of 21.7. This multiple is a median of profitable companies of 21 Machinery companies in GB including 600 Group, HMS Hydraulic Machines & Systems Group and Tex Holdings. One could put it like this: the market is pricing IMI as if it is roughly average for its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to IMI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with IMI, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing IMI to are fairly valued by the market. If this does not hold, there is a possibility that IMI’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on IMI, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for IMI’s future growth? Take a look at our free research report of analyst consensus for IMI’s outlook.
Past Track Record: Has IMI been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of IMI’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
